Depreciation methods: the four types, with formulas and examples

Every depreciation method answers the same question: how much of an asset's cost to expense this year. Over the asset's life they all reach the same total. What changes is the timing, meaning how much lands in the first year, how much in the last, and what the asset is carried at in between. This guide works one asset through each method, then covers MACRS, how to choose a method, and what changing methods involves.

What a depreciation method decides

The Federal Reserve's property and equipment accounting manual defines depreciation as "the accounting process of allocating the cost of tangible assets to current expense," done "in a systematic and rational manner in those periods expected to benefit from the use of the asset." A depreciation method is the system for that allocation.

Three inputs are settled before the method is chosen:

• Cost: what the asset cost to buy and get ready for use. What is a fixed asset? covers what gets capitalized.
• Salvage value: what you expect the asset to be worth when you stop using it.
• Useful life: how long you expect to use it, in years, or for units of production, in hours, miles or output.

Cost minus salvage value is the depreciable amount. The method decides only how that amount is spread. Each period's share is the depreciation expense, and the running total is accumulated depreciation.

The four depreciation methods at a glance

The first three are time-based: the asset's life is measured in years, whatever happens in them. Units of production measures life in use instead.

One asset, four methods

A delivery van costs $42,000, is expected to last six years and sell for $6,000 at the end, and goes into service in January. It is expected to run 150,000 miles. The depreciable amount is $42,000 − $6,000 = $36,000.

Units of production follows the miles driven rather than the calendar. At the mileage in its section below, it takes $7,200 in year one, falling to $5,040 in year six.

Every method depreciates the same $36,000 (amounts are rounded to the dollar). Only the timing differs, and that changes the van's net book value along the way. Two years in, the same van is carried at:

The figures come from the free depreciation calculator. Each section below links to it, set up with the van on that method, so you can change the numbers to your own asset.

Straight-line depreciation

Annual depreciation = (cost − salvage value) ÷ useful life

The van depreciates ($42,000 − $6,000) ÷ 6 = $6,000 a year, and its book value falls by the same amount each year until it reaches $6,000. Open the van on straight-line.

Straight-line is the most common method for a business's own books. It is easy to calculate, easy to explain, and fits assets that give much the same service every year, such as furniture, buildings and most equipment. Large organizations use it too: the Federal Reserve's manual states that "the Federal Reserve System uses the straight-line method for depreciating fixed assets."

Assets rarely go into service on January 1, so the first and last years are usually partial. If the van starts in October and your year follows the calendar, the first year takes three months, $1,500, and the nine months left over fall into a seventh year, $4,500. The fixed asset depreciation schedule guide shows how to set this up for every asset, with a downloadable template.

Declining balance depreciation: double and 150%

Depreciation = opening book value × rate ÷ useful life

Declining balance applies a fixed percentage to whatever book value is left at the start of each year, so the charge shrinks as the balance does. Double-declining balance uses twice the straight-line rate: for a six-year life, 2 ÷ 6, a third of the book value each year. The 150% method uses one and a half times the straight-line rate, 25% for six years.

Two details set it apart from the other methods:

• Salvage value is not subtracted first. The rate applies to the full book value, but the book value is never taken below salvage. For the van, year one is $42,000 ÷ 3 = $14,000, then $9,333, $6,222 and $4,148. Year five takes only $2,296, the amount that brings the book value down to $6,000, and year six takes nothing.
• Most schedules switch to straight-line. A fixed share of a shrinking balance gets smaller every year, so once straight-line over the remaining life would give a larger charge, the schedule switches to it. Under 150%, the van depreciates $10,500, $7,875, $5,906 and $4,430. In year five, straight-line over the last two years, ($13,289 − $6,000) ÷ 2 = $3,645, beats declining balance's $3,322, so years five and six take $3,645 each.

Declining balance suits assets that lose most of their value or usefulness when they are new, such as vehicles and computers. Open the van on double-declining balance or 150% declining balance.

Sum-of-years' digits

Depreciation = (cost − salvage value) × remaining years ÷ sum of the years' digits

Add up the digits of the useful life: for six years, 1 + 2 + 3 + 4 + 5 + 6 = 21. Each year takes the remaining years as a fraction of that sum, so the van depreciates 6/21 of $36,000 in year one, $10,286, then 5/21, $8,571, down to 1/21, $1,714, in year six.

Sum-of-years' digits is front-loaded like declining balance, but less steeply, and the charge falls by the same amount every year, $1,714 for the van. Because salvage value is subtracted at the start, it lands exactly on salvage value with no switch needed. Open the van on sum-of-years' digits.

Units of production depreciation

Depreciation per unit = (cost − salvage value) ÷ total expected units

Depreciation for the year = units used × depreciation per unit

Units of production ties depreciation to use instead of time. The van is expected to run 150,000 miles, so each mile costs $36,000 ÷ 150,000 = $0.24. A year of 30,000 miles is $7,200; a quiet year of 21,000 miles is $5,040:

Open the van on units of production, with six years of mileage filled in.

It suits machines whose wear follows hours run, miles driven or output, and that work harder in some years than others. It also asks the most of your records: an odometer or hour-meter reading for every asset, every period, and an estimate of the total that you revise when it proves wrong. Use beyond the expected total is not depreciated, so the book value never falls below salvage.

On a US tax return, IRS Publication 946 says that "if you can properly depreciate any property under a method not based on a term of years, such as the unit-of-production method," you can elect to exclude that property from MACRS. The election is made on Form 4562 by the return's due date, including extensions, for the year the property is placed in service.

MACRS is a tax system, not a fifth method

MACRS, the Modified Accelerated Cost Recovery System, is how most business property placed in service in the US after 1986 is depreciated on a federal tax return. It reuses the methods above, but the IRS sets the recovery period and the percentages instead of you. In Publication 946's words, "MACRS provides three depreciation methods under GDS and one depreciation method under ADS":

• 200% declining balance for nonfarm 3-, 5-, 7- and 10-year property;
• 150% declining balance for all 15- and 20-year property;
• straight-line for nonresidential real property and residential rental property;
• straight-line over the longer recovery periods of the Alternative Depreciation System (ADS).

The declining balance methods switch to straight-line "when that method provides an equal or greater deduction," as in the 150% example above. Salvage value is ignored, and conventions such as half-year and mid-quarter decide how much of the first year counts.

So many businesses keep two schedules for the same asset: straight-line in their own books and MACRS on the tax return. The difference between the two is normal and is your accountant's to track. The MACRS depreciation calculator applies the IRS tables, and the asset class lookup finds an asset's recovery period.

How to choose a depreciation method

Choose the method that matches how the asset is used up. Straight-line says the asset gives the same service every year; the front-loaded methods say it gives the most when new; units of production says its life is measured in work rather than time.

International standards rule one approach out. In May 2014 the IASB amended IAS 16 "to prohibit the use of a revenue-based depreciation method." Revenue reflects prices and sales volumes as well as use of the asset.

A few practical points matter as much as the pattern of use:

• One method per class of asset. You can use straight-line for furniture and double-declining for laptops, but treat every asset in a class the same way and keep to it, so one year can be compared with the next.
• Front-loading moves profit, not cost. A front-loaded method lowers reported profit in the early years and raises it later. Anyone comparing years, including a lender, should know which method is in use.
• Simplicity has value. Straight-line is the easiest method to explain, audit and reconcile to the general ledger, which is why it remains the default when nothing argues for another.

Changing depreciation methods

In the books, a change of method applies from the date of the change onward. Under US GAAP (ASC 250), it is treated as a change in accounting estimate effected by a change in accounting principle: earlier years are not restated, and the remaining book value is depreciated under the new method over the remaining life. The change should be justified as preferable, typically because the new method better reflects how the asset is being used.

On the tax return, a change is harder. Publication 946 lists "a change in the depreciation method, period of recovery, or convention of a depreciable asset" as a change in accounting method, and says that "generally, you must get IRS approval to change your method of accounting." That usually means filing Form 3115, which is a job for your accountant.

The depreciation guides in this series

Each of these takes one part of depreciation further:

• Depreciation expense: what the yearly charge is, where it goes on the income statement, and whether it is an operating expense.
• Accumulated depreciation: the running total each method builds, and how it reaches the balance sheet.
• Net book value: what an asset is carried at after depreciation, and why that is not its market value.
• Salvage value: how to estimate the amount every book method depreciates down to.
• Useful life of an asset: how to set and revise the period the time-based methods use.
• Fixed asset depreciation schedule: how to turn a chosen method into a schedule that reconciles to the ledger, with a template.
• Depreciation journal entries: how to record each period's depreciation, whichever method produced it.
• Fully depreciated assets: what happens when the schedule has run out and the asset is still in use.

How AssetCenter fits

AssetCenter's fixed asset management software includes a depreciation report that works out current-year depreciation, accumulated depreciation and net book value for every asset. A method picker switches the whole report between straight-line, double-declining balance, 150% declining balance, sum-of-years' digits and MACRS, and the figures match the free calculator to the cent.

Useful life is set on each asset category and salvage value on each asset. Under the book methods, nothing depreciates below its salvage value, and declining balance switches to straight-line by default, with an option to turn the switch off. The month of purchase counts as a full month, the first and last years are prorated from there, the figures can follow your fiscal year, and the report exports to Excel.

The report has no units-of-production method; use the calculator for that. AssetCenter does not post journal entries, keep separate book and tax values, or replace your general ledger.

Frequently asked questions

What is the most common depreciation method?

Straight-line, for a business's own books. It is simple and suits assets that give steady service. For US tax returns, most business property is depreciated under MACRS.

Which depreciation method gives the largest first-year expense?

Among the book methods, double-declining balance. For the van it is $14,000 in year one, against $6,000 under straight-line. On a tax return, Section 179 expensing and bonus depreciation can expense far more in the first year; the Section 179 calculator works both out.

What are the three methods of depreciation?

Courses often teach three: straight-line, declining balance and units of production. Sum-of-years' digits is the fourth common method, and MACRS is the US tax system built from the declining balance and straight-line methods.

Does salvage value matter for every method?

Straight-line, sum-of-years' digits and units of production subtract it before spreading the cost. Declining balance applies its rate to the full book value but stops at salvage value. MACRS ignores it.

Can a business use different methods for different assets?

Yes. A business can use different methods for different classes of asset, as long as each class is treated consistently from year to year.

Next step

Take one of your own assets, enter its cost, salvage value and useful life in the depreciation calculator, and compare straight-line with the method that seems to fit how the asset is used: the first-year charge and the net book value after two years show the difference. Then use the fixed asset depreciation schedule guide to apply the method you choose to every asset in the class.

By Jeremy Francis

Founder & CEO, AssetCenter